Divergences Deepen, Bulls Stand Firm

By Dr. Duru written for One-Twenty

October 28, 2007

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I have written several missives about the divergence of performance in the markets between the global growth, cheap dollar, high-tech plays and the recessionary housing sector and the retail plays clinging to dear life.

Almost a week ago, Coach (COH), one of the last premium plays in lady's apparel and fashion still standing, finally fell out of favor. After at least five straight quarters of beating guidance by lower and lower margins, COH gave up the ghost in its latest earnings report and guided both Q2 and FY08 downward by the tiniest of fractions below analyst consensus. This was all the news the market needed to knock the stock down by 12% on the day - COH's largest post-earnings fall in at least five years, perhaps in its entire 6 1/2 years as a public company. This follows a string of extremely poor performance in this sector. The weekly chart below shows how poorly COH has performed this year. It is now sitting on top of critical support created by the short-term triple top of 2006.

weekly chart of Coach (COH)

With Nordstrom (JWN) crashing right before COH - JWN is down almost 20% this month alone - we can officially call an end to the divergence in retail stocks between the haves and the have nots. And with the retail sector ETF, RTH, down for the year and still struggling below the Fed rate cut levels of September, we must really wonder whether the consumer is finally in trouble. The rich are joining the poor in the retail downtrend. So, this former divergence is converging to deepen the divergence between retail stocks and the rest of the stock market.

A divergence I recently noticed is between semiconductor stocks (SMH) and the tech sector in general (QQQQ). I noticed because, silly me, I decided to play SMH as one of my entries for riding the tech bull (click here for my disclaimer). Unfortunately, the semiconductors have been convincingly thrown off the ride. I like to use the QQQQ to represent tech stocks since it consists of the "top 100" tech stocks. The top 25 holdings are about 63% of the index, and there are few semiconductor stocks in the group. The graph below shows that the QQQQ has been steadily gaining ground on the SMH since the middle of 2003. In just the past month and a half, the QQQQ has surged against the SMH. Even if we account for MXIM dropping out of the SMH, we would still find semiconductors increasingly lagging tech. After Intel's good news a few weeks ago, several important semiconductor stocks have blown up or otherwise dropped hard: BRCM, SNDK, TXN, ALTR, AMAT, LRCX, FORM, LSI, etc...the list goes on and on. Given the cyclical nature of semiconductors, we find another divergence suggestive of a recessionary trend. So, if tech acts like retail this year, the semiconductors are telling us that the rest of tech will eventually have to come back down to earth. Of course, there is nothing in the "rule book" that says this must happen. This chart is just something to think about, keep an eye on, etc...

QQQQ outperforms the SMH

Finally, none of these divergences have taken out the market in general. The bulls continue to stand firm as they defend the S&P 500 at critical junctures of support. In September, the imprtant defense occured as the bulls rallied back from what at the time seemed like an awful jobs report. Last week, the market essentially rallied abck from another recession scare that Caterpillar (CAT) help to fuel. The chart below shows all the action.

S&P 500 stands firm

We next get Fed drama on Halloween. While the market response should be less dramatic than the last time around, I remain bullish for the rest of the year from here. I am waiting for 2008 to see whether the growing market divergences get resolved to the downside. Be careful out there!

DR. DURU®, 2007